Takeaways from the Taiwan Election
Taiwan produces over 60% of the world’s semiconductors and manufactures 90% of the most advanced chips. Taiwan’s centrality to the global economy requires us to be cognizant of the risks around its cross-strait relationship.
Taiwan held its national elections for the presidency and parliament this month. In line with market expectations, the Democratic Progressive Party (DPP) candidate Lai Ching-te won the presidency albeit with a non-DPP legislative majority in parliament. Given that this was largely priced in, market reaction has been muted. While we agree that the election itself has not triggered an event, the presence of a new Taiwanese leader in 2024 still means that some residual downside risk emanates over the course of the year.
In particular, the new Taiwanese administration has to ensure it delivers the right balancing act in its foreign relations during the upcoming months. As with any new government, this entails some execution risk, especially since Mr. Lai was Beijing’s least-favored candidate. Furthermore, Taiwanese politics notwithstanding, there are potential external drivers of heightened tensions in the Taiwan Strait. These could originate from the current US-China dynamic, especially with the looming US presidential election, which offers a canvas for foreign actors to influence by way of a foreign policy incident.
The focus here is less on extreme tail risks such as military conflict and more on the plausibility of scenarios of intermediary escalation (for instance, diplomatic saber rattling, naval or aerial incursions, temporary blockades, among others) that could generate a global market risk-off event. In particular, the transition period between Taiwanese administrations (from February 1 to May 20) is somewhat fragile as Beijing could choose to test the incoming government, after the new parliament has taken seat. The parliament is not only dominated by the opposition, but is also fragmented, which means that there is scope for more internal disagreements than before.
Alternative sources of risks are measures and rhetoric in the context of the US election. The key point is that market impact could be disproportionate as any Taiwan crisis could be viewed as a low likelihood/high impact combination – even if serious escalation were deemed to be very unlikely, the consequences could be dire. In the event of a war, a recent Bloomberg Economics report estimated the loss in global GDP to be at least double the contraction experienced during the Global Financial Crisis (GFC).
Taiwan’s centrality to the 21st century global economy – in the form of its dominance of the semiconductor industry – means financial markets need to monitor cross-strait relations carefully. Taiwan dominates the market for global foundries, outcompeting other Asia-based peers. This understates Taiwan’s qualitative edge in that the island is the sole producer of the most advanced semiconductors available today.
Finally, while the manufacturing locations of the foundries are diversifying, this will happen at a very slow pace, which means global reliance on Taiwan is likely to persist well into the 2030s. Geopolitical risk is indeed growing – not only due to China’s fear of Taiwan’s social trends toward identifying as a separate state – but also as Western pressure is beginning to impact the relative direction of Taiwanese exports (Figure 2).
Investment Implications
Given Taiwan’s exchange rate policies, the Taiwanese dollar is less adept at signalling future tensions compared with equity indicators. Increased episodes of risk-off events expected in relation to Taiwan’s foreign relations may result in a spike in cross-asset volatility over upcoming months. This is in addition to the negative tailwinds of armed conflict in Ukraine and the Middle East as well as risks related to the upcoming US presidential election.